Institutional Investor's Alpha Magazine - March 2008 - (Page 39) folios and thinking about adding managers focused on distressed investments to give them that exposure at a time when other strategies might be less attractive. How will hedge fund allocations be affected? understand what the risk exposures are and how that might actually be similar to something that has historically been in a different slice of the pie. What has surprised you most about how the hedge fund industry has evolved? We’re likely to cut back on some strategies to make room for new managers. How that will be done will vary on a portfolio-by-portfolio basis, depending on where a client might be overly allocated. It’s not likely to lead to a wholesale termination of managers, but [rather to] some partial withdrawals to create cash for other strategies. Are there hedge fund strategies Cambridge Associates avoids? I think hedge funds have continued to deliver a very attractive pattern of returns in spite of the concerns that asset growth was going to kill the industry. And I think, particularly as we move into a more challenging market environment, hedge funds will continue to be an attractive vehicle for most classes of investors. Do you think market saturation is no longer an issue? Yes. Those include global macro, fi xed-income arbitrage and trading strategies like CTAs — commodity trading advisers. And generally, we don’t use market-neutral funds very much. A number of things keep us from using those strategies more heavily. Some of them are heavily dependent on leverage, and we’re very averse to having a high degree of leverage in portfolios. We tend to be a little skeptical about quantitative models. We prefer more fundamentally driven strategies, where we can evaluate the source of return and understand the risks. Are you finding the lines blurring between strategies? I think that money will continue to come into the industry, and we’ll see firms growing to a very different scale from what they have been historically, which has a lot of implications as assets grow. How will that affect the consultant’s job? Yes, it’s getting harder and harder to put people into buckets. Some hedge fund managers are investing in a more eclectic portfolio that includes things that might overlap with private equity or that might include commodity exposure. This is happening because managers have challenges in finding new ways to generate return. It’s in its early stages, but I think it is going to be an important theme in endowment management. Describe some of these hybrid strategies. A fund that historically might have done merger arbitrage and public distressed securities now is adding direct lending, privately negotiated debt transactions, investing in buyouts, investing in other kinds of privately owned companies. That has been the most common hybridization: classic multistrategy funds or some newly launched multistrategy funds that are including a series of private investments alongside the public things. How are your clients coping with strategy overlap in their asset allocation models? As organizations become more complex, as decision making somewhat inevitably gets dispersed a mong more d if ferent people in an organization, the evaluation of individual fi rms is going to become a lot more challenging. Inevitably, as I think is always the case, some firms will manage — BURTON SONENSTEIN, CIO, that growth well and othANNIE E. CASEY FOUNDATION ers won’t. As the number of employees grows, as the number of strategies and decision makers increases, as the volume of assets increases, evaluation and monitoring become more challenging. Where else is the hedge fund industry headed? “We’ve had our share of hedge fund blowups — like Amaranth and Sowood — but there haven’t been any events in Cambridge Associates’ portfolio.” Broadly there is a trend of institutions thinking differently about how to categorize their investments. There isn’t a consistent answer that people are coming up with, but I think there is a general recognition that the historical slices of the pie that were private equity, venture capital and absolute return are becoming less meaningful as a way of controlling risk and allocating assets to achieve return objectives. People are being creative in structuring new categories, number one, but also looking more carefully through the funds to see what’s in them and The U.S. market is still more closely followed by more talented managers and is somewhat more efficient. By allocating more of their assets to overseas markets, managers are broadening their horizons and achieving the kind of diversifi cation in portfolios that is desirable. Because if you have 20 managers all looking at the same market and investing in the same securities, you’re not necessarily as fully diversified as you are if you have managers who are in different markets looking at different securities and maybe looking at them in a different way. We have hedge fund people in Singapore and in London, and we are identifying more and more managers outside the U.S. that we’re bringing into client portfolios. MARCH 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 39
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